Fitch Ratings last week said it expected to downgrade roughly 27% of the tranches of synthetic CDOs referencing U.S. subprime securities by an average 2.4 notches, given a recent stress test applied to the deals it's rated. The rating agency assumed a three-notch downgrade on each of the investment grade subprime RMBS within the CDO portfolios.
However, Fitch pointed out that a number of factors - including deal structure, market conditions and the individual asset manager - make such projections difficult. "The full impact of the subprime RMBS exposure on synthetic SF CDOs will
likely not be felt until the second half of 2007, when more information regarding mortgage performance materializes."
Fitch's sample size consisted of 203 tranches from 72 outstanding synthetic CDOs with exposure to U.S. subprime RMBS. The deals account for about 9% of Fitch-rated CDOs.
U.S. synthetic CDOs referencing subprime had a collective $10.3 billion of exposure, with an average 55% exposure per portfolio. Meanwhile, European deals had a collective $27.5 billion exposure and an average 27% portfolio exposure. At 91%, nearly all of the Fitch-rated European CDOs with exposure to U.S. subprime were static deals, while only 38% of U.S. CDO exposed to subprime were static transactions.
Assuming base case amortization, a three-notch downgrade for investment-grade U.S. subprime securities and a six-notch downgrade for non-investment grade securities, Fitch found an average downgrade to synthetic CDO tranches of 2.4 notches. A "small number" of CDOs tested under the criteria experienced downgrades of up to seven notches, although the rating agency said such an event is "unlikely," because of a large concentration of highly rated securities within the underlying exposures.
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